Mid-size banks and building societies – is evolution enough to survive the revolution? (Part 1)

Personal banking has changed dramatically in the ten years since the financial crisis. Regulation has changed significantly, a low interest rate environment has prevailed and consumer demand for access to financial services via tablets or smartphones has undoubtedly been influenced by their burgeoning retail experience with the likes of Amazon, Asos and Wiggle.

The evolving considerations and subsequent strategies amongst the mid-size players is an area of particular interest as the financial services landscape continues to embrace an environment of increased competition. The nature of this changing landscape necessitates additional investment by organisations in order to remain competitive.

Mid-size banks and building societies (who do not possess the scale or financial firepower of their larger peers), have arrived at a key strategic decision point and must now ask themselves if evolution is enough or is a more revolutionary approach required?

Table 1: UK Banking Total Lending & Deposits

We have considered the different approaches being adopted in this ‘mid-size’ retail banking sector (defined as c. £5,000m to £35,000m total lending and deposits - see Table 1 above) and used Grant Thornton’s Strategic Lever model illustrated below to review.

Grant Thornton’s Strategic Lever Model

This model considers four key phases or ‘Strategic Levers’ which are important to facilitate strategic development:

Focus – define the core offering and reduce complexity

LeverageStrengths – identify areas of investment and capability from within

Bridge Capability Gaps – invest in areas of weakness which are in demand from the marketplace

All phases of this model need to be planned at the outset and executed sequentially if the objective is to have a self-funding business case. Despite this, it is not uncommon to see firms move prematurely to the ‘Bridge Capability Gaps’ stage (particularly when this involves innovation), having failed to identify a clear Focus. Often ‘Bridge Capability Gaps’ initiatives are a copycat response to a competitor’s launch of a new offering (cast your mind back to the spate of smartphone banking apps and mobile wallets a few years ago!) without always considering how this would be positioned within an organisation’s overall proposition for each of their target customer segments. This lack of a clear strategy and roadmap to deliver typically results in a more complex change programme and increases the probability of having to escape from a self-imposed ‘cul-de-sac’.

Strategic Levers

Phase 1: Focus

Historically, banks and building societies have had a sizeable product range, which lacked focus or specialisation. Today a streamlined, focused and comparatively smaller product range is essential both to simplify the landscape for consumers and satisfy regulators.

Some building societies have recognised the benefits of this and have subsequently reduced their product set. Yorkshire Building Society (YBS) is perhaps the most prominent example after decommissioning their current account and getting back to their brilliant basics of offering mortgages and savings in a mutual wrapper.

In retail banking, Metro Bank’s original strategy of face to face distribution with a simple product set is a great example of Focus (although they have now extended both their distribution reach and customer demographic profile).

To decommission legacy products and subsequently refocus capability is no small feat. Whilst the bigger players are tied down by the red tape attached to simplifying a large product range and dealing with legacy issues associated with these, mid-size firms, providing they are able to take clear decisions and execute swiftly, are presented with an opportunity to gain a head start by reducing their comparatively smaller product set.

Decisions need to be taken on which products are core and which are non-core. This allows for the freeing up of capital, as well as a reduction in cost to service by utilising value adding strategies such as outsourcing non-core products and the sale of closed portfolios and back books.

Other weaker aspects of the operation must also be deprioritised. The decline of the high street means that for retail banks and building societies, financial resource must be allocated more efficiently. Last year alone, 201 high street retail bank stores closed; the majority of which were from the big 5 banks as they continue to invest in digital capability. However, the problem is not theirs alone as many of the mid-size players may be over-represented in certain geographies e.g. TSB and CYBG both have extensive branch networks in Scotland.

From a strategic perspective, the objective of the Focus stage is to reduce complexity and concentrate effort on their most valuable or target customer sets, core offerings and capabilities – in effect ‘clearing the deck’ to optimise future strategic growth potential.

Phase 2: Leverage Strengths

The mind-set of the financial services industry is, by necessity, increasingly consumer orientated. Therefore, upon optimising areas of Focus, the next phase in the evolutionary strategic development model suggests that mid-size players should build on this by using existing organisational strengths. They should determine where their customers feel they excel and what products, customer journeys and distribution channels add most value to them and the organisation. Lack of clarity in this and the preceding phases can result in confusion and complications that create an investment risk in phase 3 (Bridging Capability Gaps)

The underlying questions with regards to identifying these strengths are simple - ‘What are we good at?’, ‘What factors add value?’ and therefore ‘What do we build upon?’

Some mid-size players have determined that their distribution in their geographic heartland is a strength to leverage and the resulting affinity that communities have to their local bank or building society is a factor that attracts depositors and borrowers. This consequently generates a healthy flow of business as well as potentially producing something of a cash cow to support investments required in phase 3 (Bridge Capability Gaps).

Virgin Money have excelled in developing their share of the mortgage market and consequently improving their balance sheet since acquiring Northern Rock and absorbing their intermediary infrastructure; leveraging this to grow their lending.

Additionally Nationwide, although sitting above the mid-size catchment, have perhaps shown the others how to leverage their mutuality with a series of adverts drawing attention to the fact that they are a building society rather than a bank, albeit to compete with and attract customers from the big 5 banks (HSBC, LBG, Barclays, RBS and Santander).

Summary

There are clear and defined areas of investment as a result of combining the first two phases of strategic evolution. Taking an evolutionary rather than revolutionary approach to strategic development reduces the likelihood of mid-size players sinking significant investment into their digital build which will fail to deliver competitive advantage. The long term benefits of this process are potentially intangible as firms establish a solid foundation on which they can continue to build upon. However, short-to-medium term investment payback should be evident and this plays into the concept of a self-funding business case.

In the next article, we will assess the final two phases of the evolutionary model; exploring how mid-size banks and building societies can bridge gaps and innovate in order to grow their business. This will be done by locating the optimal areas to invest, in order to successfully Bridge Capability Gaps and truly differentiate their proposition.